Prescription Drugs: An Overview of Approaches to Negotiate Drug Prices Used by Other Countries and U.S. Private Payers and Federal Programs

Prescription Drugs: An Overview of Approaches to Negotiate Drug
Prices Used by Other Countries and U.S. Private Payers and
Federal Programs (11-JAN-07, GAO-07-358T).

Rising prescription drug spending has led the United States and
other countries to seek ways to negotiate lower prices with drug
manufacturers. Currently, the Medicare Part D benefit, which
offers outpatient prescription drug benefits to beneficiaries
including elderly and certain disabled people, comprises
competing prescription drug plans overseen by the Centers for
Medicare & Medicaid Services. The Medicare Prescription Drug,
Improvement, and Modernization Act of 2003 prohibits the
Secretary of Health and Human Services from interfering with
price negotiations between Part D plan sponsors and drug
manufacturers and pharmacies. Some Members of Congress have
proposed amending the statute to allow the Secretary of Health
and Human Services to negotiate directly with drug manufacturers
on behalf of Part D beneficiaries. GAO was asked to describe how
prescription drug prices are negotiated. This testimony provides
an overview of such efforts (1) by governments in other
countries; (2) by U.S. private payers, such as employer-based
health plans; and (3) by federal programs other than Medicare
Part D. This testimony is based on previous GAO reports from 2002
through 2006 on federal programs that purchase or cover
prescription drugs and other relevant literature from
congressional agencies and federal or international
organizations.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-07-358T
ACCNO: A64787
TITLE: Prescription Drugs: An Overview of Approaches to
Negotiate Drug Prices Used by Other Countries and U.S. Private
Payers and Federal Programs
DATE: 01/11/2007
SUBJECT: Comparative analysis
Cost analysis
Drugs
Financial analysis
Health care programs
Medicaid
Medicare
Pharmaceutical industry
Prescription drugs
Prices and pricing
Rebates
Medicare Part D

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GAO-07-358T

* [1]Background

* [2]Prescription Drug Spending and Cost Containment Strategies i
* [3]Federal Programs

* [4]Approaches Used by Other Countries for Negotiating Drug Pric
* [5]Approaches Used by U.S. Private Payers for Negotiating Drug
* [6]Approaches Used by U.S. Federal Programs for Negotiating Dru

* [7]VA and DOD
* [8]Medicaid
* [9]The 340B Drug Pricing Program
* [10]Medicare Part B
* [11]FEHBP

* [12]Contacts and Acknowledgments
* [13]Related GAO Products

* [14]Order by Mail or Phone

Testimony

Before the Committee on Finance, U.S. Senate

United States Government Accountability Office

GAO

For Release on Delivery Expected at 10:00 a.m. EST

Thursday, January 11, 2007

PRESCRIPTION DRUGS

An Overview of Approaches to Negotiate Drug Prices Used by Other Countries
and U.S. Private Payers and Federal Programs

Statement of John E. Dicken Director, Health Care

GAO-07-358T

Mr. Chairman and Members of the Committee:

I am pleased to be here today as you examine approaches for prescription
drug pricing and negotiations. In the United States and in other
countries, the rising cost of prescription drugs continues to pose
significant financial burdens on governments, private payers, and
individuals responsible for paying for drugs. This has led to a wide range
of market-based and governmental approaches to reduce drug spending. Some
of these approaches rely on negotiations between payers for prescription
drugs and drug manufacturers.

In the United States, prescription drugs are a particular focus for the
federal government as Medicare--the federal health insurance program that
serves nearly 43 million elderly and disabled individuals--begins the
second year of its voluntary outpatient prescription drug benefit. This
benefit, known as Medicare Part D, was established by the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003 (MMA)
beginning January 1, 2006.^1 Medicare beneficiaries may choose a Part D
plan from multiple plans offered by private sponsors, largely commercial
insurers, under contract with the Centers for Medicare & Medicaid Services
(CMS), the agency within the Department of Health and Human Services (HHS)
that administers Medicare. These plans differ in the drugs they cover, the
pharmacies they use, and the prices they negotiate with drug manufacturers
and pharmacies. In addition, costs to the enrollee for the monthly
premium, the annual deductible, and copayments for covered drugs vary by
plan.

While the Medicare Part D benefit is characterized by multiple competing
prescription drug plans that are overseen by CMS, MMA prohibits the
Secretary of Health and Human Services from interfering with price
negotiations between Part D plan sponsors and drug manufacturers and
pharmacies.^2 Some Members of Congress, contending that the combined
purchasing power on behalf of all Medicare Part D beneficiaries could be
used as leverage, have proposed amending the law to provide for the
Secretary of Health and Human Services to negotiate directly with drug
manufacturers.^3

1Pub. L. No. 108-173, S 101, 117 Stat. 2066, 2071-2152 (codified at 42
U.S.C. SS 1395w-101 to 1395w-152). MMA redesignated the previous part D of
title XVIII of the Social Security Act as part E and inserted a new part D
after part C.

^2Pub. L. No. 108-173, S 101, 117 Stat. 2066, 2098 (codified at 42 U.S.C.
S 1395w-11(i)).

As Congress considers these issues for Medicare Part D, you asked that we
broadly describe the variety of approaches used to negotiate drug prices.
Specifically, my remarks today will provide an overview of the approaches
used to negotiate drug prices by governments in other countries, by
private payers in the United States, and by federal programs other than
Medicare Part D.^4 My remarks are primarily based on our previous reports
from 2002 through 2006 on federal programs that purchase or cover
prescription drugs, which were done in accordance with generally accepted
government auditing standards, as well as other relevant literature on
approaches in the United States and other countries prepared by
congressional agencies and international and federal organizations.^5

In summary, a wide range of approaches is used by other countries and by
private payers and federal programs in the United States to negotiate drug
prices. The approaches governments in other countries use include the
following:

o Ceiling prices restrict market negotiations by setting maximum
prices purchasers can pay for drugs. Ceiling prices allow
purchasers to negotiate lower prices directly with drug
manufacturers.
o Reference prices use local or international price comparisons of
drugs classified in a group as therapeutically similar to
determine a single or maximum price for all drugs in that group.

o Profit limits establish controls on drug manufacturers' profits
that require manufacturers to pay rebates or lower prices if
profits exceed certain levels.

Other key factors--such as scope of coverage and national
formularies, which are generally lists of preferred
drugs--influence drug price negotiations.

Private payers in the United States, including employer-based
health plans and private insurers, typically contract with
pharmacy benefit managers (PBM). PBMs negotiate rebates or
payments with manufacturers and prices with retail pharmacies, and
they provide other related administrative and clinical services.
PBMs compete in the private market based on their ability to
negotiate reduced prices and contain costs, and PBMs may receive
compensation from health plans and from retaining some of the
savings they negotiate with pharmacies or manufacturers. PBMs
influence price negotiations with manufacturers through formulary
development and management and through the large number of health
plan enrollees they typically represent.

Approaches for negotiating drug prices vary among federal programs
in the United States. Factors contributing to this variation
include the use of formularies and whether the programs purchase
and distribute drugs, reimburse retail pharmacies or other
providers for drugs dispensed and delivered, or contract with
private health plans that provide and manage pharmacy benefits.
For example, the Department of Veterans Affairs (VA) and the
Department of Defense (DOD) often purchase drugs from suppliers,
then distribute drugs to beneficiaries through internal facilities
or mail-order pharmacies. State Medicaid programs, on the other
hand, reimburse retail pharmacies for drugs dispensed to
beneficiaries at set prices. While the approaches used by federal
programs in the United States reflect the laws governing them,
markets, and health care delivery and financing, there are also
elements common to some of the approaches used by other countries
and by private payers. Some federal programs set ceiling prices,
others establish prices by referencing prices negotiated by
private payers in the commercial market, and still others rely on
negotiations with manufacturers, either directly or through
private health plans. For example, VA's and DOD's prices for
particular prescription drugs included on their formularies may be
the lowest of a ceiling price, a price listed on a federal supply
schedule (FSS), or the price negotiated with a manufacturer. For
health benefits offered to federal employees, retirees, and their
dependents, the federal government uses a different approach,
modeled after other large U.S. employers' health benefits. Under
this approach, rather than the government negotiating with
manufacturers, the government contracts with participating health
plans that typically use PBMs to negotiate drug prices, manage
formularies, and offer other pharmacy benefit, administrative, and
clinical services.

Prescription Drug Spending and Cost Containment Strategies in
Other Countries and the United States

Prescription drug spending, paid for by a mix of public and
private payers, has outpaced total health care spending in the
United States and other countries in recent years. In the United
States, federal programs either directly purchase and distribute
prescription drugs or reimburse pharmacies or other providers for
drugs dispensed or delivered.

According to the Organisation for Economic Co-operation and
Development (OECD), drug spending in member countries (including
the United States) increased on average by about 6 percent a year
from 1998 through 2003.^6 On average, growth in drug spending
outpaced the growth in spending for total health expenditures.
Among OECD member countries, the share of public and private
spending for prescription drugs varies, but in 2004 public sources
accounted for the bulk of spending in most countries.

In the United States, rising prescription drug prices and
increased spending have been a concern to federal and state
governments and to private payers, including private insurers and
employer-based health plans. CMS reports that total national
spending by all public and private payers for prescription drugs
from retail outlets increased on average by about 11 percent a
year from 1998 through 2005--faster than the average 7 percent a
year increase in total U.S. health expenditures for the same
period.^7 CMS also reports that national spending by all public
and private payers for prescription drugs from retail outlets
totaled about $201 billion in 2005. Nearly three-quarters (73
percent) of this spending came from private funds--including
private insurance and out-of-pocket payments--while the remaining
share came from public sources. The public share includes the
federal government's share of total spending for prescription
drugs from retail outlets. Federal spending for prescription drugs
was about 16 percent of the total, or $33 billion, in 2005.
However, these data precede the 2006 establishment of Medicare
Part D, which increased public and federal shares of prescription
drug expenditures.

In the face of rising prescription drug spending, the governments
of other countries, U.S. private payers, and federal programs have
applied both demand- and supply-side measures to contain
prescription drug spending. Demand-side measures are aimed at
wholesalers, retailers, doctors, and patients and include such
strategies as prescribing guidelines, generic substitution
policies, and fixed and tiered copayments. Supply-side measures
are aimed at limiting the cost of prescription drugs by
negotiating prices and by requiring or encouraging the use of
certain drugs through formularies established by a government,
health plan, or federal program. Formularies have long been used
to control the cost and utilization of prescription drugs. Some
formularies are more restrictive than others; open formularies
provide coverage for both listed and nonlisted drugs, and closed
formularies generally provide coverage only for drugs that are
included on the list. Many other formulary approaches fall
somewhere in between, encouraging the use of listed drugs by
charging higher copayments for those not listed. Under a tiered
cost-sharing approach, for example, generic and preferred drugs
require lower copayments than brand and nonpreferred drugs. Health
plans that use formularies typically have provisions that enable
enrollee access to nonformulary drugs when they are medically
necessary and allow patients to appeal coverage decisions.

In the U.S. private market, PBMs offer health plans a variety of
prescription drug management services, including negotiating
rebates with manufacturers, negotiating price discounts with
retail pharmacies, operating mail-order prescription services,
managing drug formularies, and processing claims. PBMs also
provide health plans with clinical services, such as formulary
development and management, prior authorization and drug
utilization reviews to screen prescriptions for such issues as
adverse interactions or therapy duplication, and substitution of
generic drugs for therapeutically equivalent brand drugs.^8 Health
plans pay PBMs fees for these administrative and clinical services
as well as for retail and mail-order drug costs. PBMs may also
retain savings from or have other financial incentives to
negotiate lower drug prices and rebates. In 2004, an estimated 200
million people, or about 68 percent of the U.S. population, were
enrolled in private health plans that used PBMs.^9

Federal Programs

Beyond Medicare Part D, a range of federal programs, established
by statute, in the United States offer drug benefits to
individuals meeting various eligibility criteria. These programs
cover a broad and varying array of prescription brand and generic
drugs.^10 These drugs are made available to beneficiaries through
multiple approaches, ranging from direct purchase and provision by
federal programs to contracts with private insurers and PBMs to
provide drug coverage.

The VA pharmacy benefit is provided to eligible veterans and
certain others. In general, medications must be prescribed by a VA
provider, filled at a VA pharmacy or through a VA Consolidated
Mail Outpatient Pharmacy, and listed on the VA national drug
formulary, which comprises 570 categories of drugs. In addition to
the VA national drug formulary, VA facilities can establish local
formularies to cover drugs not on the national formulary. VA may
provide nonformulary drugs in cases of medical necessity.^11 In
2005, VA spent $4.2 billion on drugs and medicines.

The DOD pharmacy benefit is provided to TRICARE beneficiaries,^12
including active duty and retired uniformed service members. In
addition to maintaining a formulary, DOD provides options for
obtaining nonformulary drugs. Beneficiaries can get prescription
drugs through network retail pharmacies, nonnetwork retail
pharmacies, DOD military treatment facilities, and DOD's TRICARE
Mail Order Pharmacy. In 2005, DOD spent $5.4 billion on
prescription drugs.

Medicaid is the joint federal-state program that finances medical
services for certain low-income adults and children. While some
benefits are federally required, prescription drug coverage is an
optional benefit that all states have elected to offer. State
Medicaid programs, though varying in design, cover both brand and
generic drugs. Drug coverage depends on the manufacturer's
participation in the Medicaid drug rebate program, through which
manufacturers pay rebates to state Medicaid programs for covered
drugs used by Medicaid beneficiaries. Retail pharmacies distribute
drugs to Medicaid beneficiaries, then receive reimbursements from
states for the acquisition cost of the drug and a dispensing fee.
In 2004, Medicaid outpatient drug spending peaked at $31
billion--including $19 billion as the federal share--which was
calculated after adjusting for manufacturer rebates to states
under the Medicaid drug rebate program. Medicaid spending on
outpatient prescription drugs is expected to decrease with the
transition of prescription drug coverage for dual eligibles--those
eligible for both Medicaid and Medicare--to the Medicare Part D
program.

The 340B drug pricing program gives more than 12,000 entities of
various types--community health centers, AIDS clinics, and
disproportionate share hospitals^13 among them--access to
discounted drug prices, called 340B ceiling prices.^14 These
entities must enroll in the program, which is administered by the
Health Resources and Services Administration. The program requires
drug manufacturers to offer covered drugs to enrolled entities at
or below 340B ceiling prices.^15 Enrolled entities establish their
own formularies and may dispense drugs through in-house
pharmacies, dispensing physicians, or contracted retail
pharmacies. Enrolled entities spent an estimated $3.4 billion on
drugs in 2003.

Medicare, the federal health insurance program that serves the
nation's elderly and certain disabled people, in addition to the
outpatient prescription drug benefit offered in Part D, covers
certain other drugs through Part B.^16 Drugs covered by Part B are
typically administered by physicians or other medical
professionals rather than by patients themselves. These drugs
include, for example, those furnished in conjunction with dialysis
services or durable medical equipment. In 2005, Medicare paid more
than $9 billion for drugs covered under Part B.

The Federal Employees Health Benefits Program (FEHBP) is the
largest employer-sponsored health insurance program in the
country. Through it, about 8 million federal employees, retirees,
and their dependents receive prescription drug coverage through
participating private health insurance plans. Most of these plans
contract with PBMs to manage their drug benefits. The drugs
covered vary by plan, but are typically part of relatively broad
formularies of drugs. In general, beneficiaries have several
options for obtaining drugs, including through retail or
mail-order pharmacies. In 2005, FEHBP prescription drug spending
was an estimated $8.3 billion.

Approaches Used by Other Countries for Negotiating Drug Prices

According to the OECD, member countries that offer subsidized drug
programs are grappling with how to manage increased drug spending
given limited budgets. These countries have three main approaches
to limiting the amount they pay to acquire drugs:

o ceiling prices,

o reference prices, and

o profit limits.

Ceiling prices. Ceiling prices restrict market negotiations by
setting maximum prices purchasers can pay for drugs. Ceiling
prices allow purchasers to negotiate lower prices directly with
drug manufacturers. One approach is for a government to set prices
for drugs and prohibit sales at greater prices. In France and
Australia, for example, a government committee sets the prices at
which drugs must be purchased and reimbursed. Alternatively, a
government may set a price ceiling and allow purchasers to
negotiate more favorable prices with manufacturers directly. In
Canada, the Patented Medicines Prices Review Board sets the
maximum price a manufacturer can charge direct purchasers. It can
impose fines on any manufacturer that attempts to sell a drug at a
price greater than the established ceiling. An additional method
used to control prices is for a government to set reimbursement
rates for new drugs at low levels; because any price above the set
reimbursement rate would be an out-of-pocket expense to the
consumer, the reimbursement rate effectively becomes the market
price.

Reference prices. Reference prices use local or international
price comparisons of drugs classified in the same therapeutic
group to determine a single or maximum price for all drugs in that
group. The therapeutic group of drugs can encompass old and new
drugs, including brand or generic drugs. The lowest priced drug
may then establish the maximum price for the entire therapeutic
group. Germany, for example, sets such prices based on local price
comparisons of drugs classified in the same therapeutic group.

Profit limits. Profit limits control the amount of profit a drug
manufacturer may earn on a product or within a specified period of
time. If the established threshold is exceeded, the manufacturer
is required to accept a price cut or pay rebates to the
government. In the United Kingdom, for example, there are limits
on the profits that a drug manufacturer can earn on sales to the
National Health Service.

Several other key factors can influence drug price negotiations in
OECD countries. Unlike the United States, many OECD countries,
such as Australia and France, have universal health care systems
that allow a mandated, relatively more unified approach to drug
pricing. While these countries vary in their government's
respective share of drug spending, some set national, uniform
maximum prices to be paid by all purchasers, including private
payers. Many countries also establish national formularies that
define which drugs are to be covered by all purchasers.

Approaches Used by U.S. Private Payers for Negotiating Drug Prices

In the United States, private payers represent the largest source
of prescription drug spending. These payers, including
employer-based health plans and private health insurers, typically
contract with PBMs to help manage their prescription drug
benefits. PBMs employ several cost containment strategies for
lowering drug prices for the health plans and enrollees they
represent. PBMs negotiate rebates or payments with manufacturers
and prices with networks of retail and mail-order pharmacies,
passing along at least some of the savings to health plans and
enrollees. Manufacturers and pharmacies agree to these price
concessions in exchange for both the large number of enrollees
PBMs represent and the ability of PBMs to influence enrollee
choice of drugs and pharmacies.

One of the key ways PBMs influence price negotiations with
manufacturers is through formulary development and management.
PBMs may assist health plans in developing or managing a formulary
that the health plan will cover. Health plans often provide
financial incentives, such as lower enrollee cost-sharing, to
encourage use of preferred drugs listed on the formulary.^17 Since
PBMs represent a large number of enrollees, manufacturers have a
strong interest in having their drugs listed on plan formularies.
Manufacturers pay PBMs through rebates or other payments to be
included on plan formularies and to capture greater market shares
for their drugs. For example, many mail-order pharmacies are owned
by PBMs, and PBMs can obtain greater manufacturer rebates or
payments by dispensing a high volume of the manufacturer's drug.

The extent to which pharmacy discounts and manufacturer rebates or
payments are shared with health plans and enrollees depends on
contractual arrangements with the health plan and the plan's
benefit design. For example, PBMs negotiate contracts with health
plans and their networks of pharmacies separately, which means
that health plans may pay PBMs higher prices for drugs than the
PBM negotiated between itself and the pharmacy. Similarly, PBMs
often set up contractual arrangements with manufacturers based on
manufacturers' entire line of products rather than per drug.
Further, PBMs may retain a portion of the rebates or payments they
receive associated with individual health plans or all the health
plans they represent. PBMs may also obtain additional rebates or
payments from manufacturers for administering formularies or
providing certain services, such as encouraging the use of one
therapeutically similar drug over another.

Approaches Used by U.S. Federal Programs for Negotiating Drug
Prices

Approaches for negotiating drug prices vary among federal programs
in the United States. While these approaches reflect the laws that
govern them, markets, and health care delivery and financing,
there are also elements common to some of the approaches used by
other countries and by private payers. Some federal programs set
ceiling prices, others establish prices by referencing prices
negotiated by private payers in the commercial market, and still
others rely on negotiations with manufacturers, either directly or
through private health plans. For example, VA's and DOD's prices
for particular prescription drugs may be the lowest of an FSS
price, a ceiling price, or the price that each agency can
negotiate directly with the manufacturer. The FEHBP uses a
different approach, modeled after other large U.S. employers'
health benefits; health plans participating in the FEHBP typically
contract with PBMs to negotiate drug prices and offer other
pharmacy benefit, administrative, and clinical services. Further,
like many of the other OECD countries, U.S. federal programs use a
mix of strategies to contain prescription drug spending. Many
federal programs have formularies that define which drugs are to
be covered. While some federal programs' formularies are
comprehensive and some are more restrictive than others, the
programs use lists of covered drugs as the basis for negotiations
with drug manufacturers.

VA and DOD

VA and DOD have several options available to obtain favorable
prices for drugs covered on their formularies. Both agencies pay
the lowest of several prices available for a given drug, and both
can negotiate with suppliers to receive additional discounts. In
addition, both have adopted certain practices that affect
negotiations, such as the use of formularies, or that otherwise
contribute to lower costs, such as the use of mail-order
pharmacies.

VA and DOD have access to a number of prices to consider when
purchasing drugs.

o FSS prices. VA's National Acquisition Center negotiates FSS
prices with drug manufacturers. These prices are available to all
federal purchasers. FSS prices are intended to be no more than the
prices manufacturers charge their most-favored nonfederal
customers under comparable terms and conditions. Under federal
law, drug manufacturers must list their brand drugs on the FSS to
receive reimbursement for drugs covered by Medicaid.^18 All FSS
prices include a fee of 0.5 percent of the price to fund VA's
National Acquisition Center.

o Federal ceiling prices. Federal ceiling prices, also called Big
Four prices, are available to VA, DOD, the Public Health Service,
and the U.S. Coast Guard. These prices are mandated by law to be
24 percent lower than nonfederal average manufacturer prices.^19

o Blanket purchase agreements. Blanket purchase agreements are
national contracts with drug manufacturers that allow VA and
DOD--either separately or jointly--to negotiate prices below FSS
prices. The lower prices may depend on the volume of specific
drugs being purchased by particular facilities, such as VA or
military hospitals, or on being assigned preferred status on VA's
and DOD's respective national formularies.

In a few cases, individual VA and DOD medical centers have
obtained lower prices through local agreements with suppliers than
they could have through the national contracts, FSS prices, or
federal ceiling prices.

In addition, VA's and DOD's use of formularies, pharmacies, and
prime vendors can further affect drug prices. VA and DOD
formularies encourage the substitution of lower-cost drugs
determined to be as effective or more effective than higher-cost
drugs. Both VA and DOD use prime vendors, which are preferred drug
distributors, to purchase drugs from manufacturers and deliver the
drugs to VA or DOD facilities.^20 VA and DOD receive discounts
from their prime vendors that also reduce the prices that they pay
for drugs. For DOD, the discounts vary among prime vendors and the
areas they serve. As of June 2004, VA's prime vendor discount was
5 percent, while DOD's discounts averaged about 2.9 percent within
the United States.

Unlike VA and DOD, state Medicaid programs do not negotiate drug
prices with manufacturers, but reimburse retail pharmacies for
drugs dispensed to beneficiaries at set prices. Under the Medicaid
drug rebate program,^21 drug manufacturers provide quarterly
rebates for covered outpatient prescription drugs purchased by
state Medicaid programs. The rebates are meant to take advantage
of the prices manufacturers receive for drugs in the commercial
market and are required to reflect the results of negotiations by
private payers such as discounts and rebates.

The rebates are based on two prices per drug that manufacturers
report to CMS: best price^22 and average manufacturer price
(AMP).^23 The relationship between best price and AMP determines
the unit rebate amount and thus the overall size of the rebate
that states receive for a brand drug. The basic unit rebate amount
is the greater of two values: the difference between best price
and AMP or 15.1 percent of AMP. If the drug's AMP rises faster
than inflation, the manufacturer is required to provide an
additional rebate to the state Medicaid program.^24 A state's
rebate for a brand drug is the product of the unit rebate amount
plus any applicable additional rebate amount and the number of
units of the drug paid for by the state's Medicaid program.

The 340B Drug Pricing Program

Entities eligible for the 340B drug pricing program can purchase
covered outpatient prescription drugs from manufacturers at or
below statutorily defined prices, known as 340B ceiling prices,
that take advantage of discounts resulting from the Medicaid drug
rebate program. These prices are the maximum amount eligible
entities can pay for covered drugs, and the program allows for
eligible entities to negotiate more favorable prices directly with
drug manufacturers. As such, the 340B drug pricing program offers
covered entities access to a prime vendor with which they can
contract to negotiate discounts at or below the mandatory 340B
ceiling price.

State AIDS drug assistance programs (ADAP) are examples of
entities eligible for the 340B drug pricing program. ADAPs
participating in the 340B program use either the 340B direct
purchase option or the 340B rebate option. Under the direct
purchase option, ADAPs purchase drugs from drug manufacturers or
through a third party, such as a drug purchasing agent, and ADAPs
receive the 340B price discount up front. In addition, ADAPs using
this option can access the prime vendor program to assist in
negotiating discounts at or below the mandatory 340B ceiling
price. Under the rebate option, ADAPs typically contract with
entities such as a pharmacy network or PBM for the purchase of
covered drugs and later request a 340B rebate directly from the
drug manufacturers. ADAPs using the rebate option do not have
access to the prime vendor program.

Medicare Part B

Like Medicaid, Medicare does not purchase drugs but rather
reimburses physicians for drugs covered under Part B. The maximum
Medicare reimbursement for covered Part B drugs is statutorily
defined using the average sales price (ASP) plus 6 percent.^25 ASP
is the average price for a drug based on a manufacturer's sales to
all purchasers in the United States, with certain exceptions.
Under this reimbursement methodology, Medicare takes advantage of
the prices negotiated by private payers, as ASP is required to
reflect the discounts and rebates they negotiate.^26

FEHBP

The FEHBP is generally modeled after other large U.S. employers'
health benefits, including that participating health plans
typically rely on PBMs to negotiate drug prices and offer other
pharmacy benefit, administrative, and clinical services. In a 2003
report^27 that reviewed the use of PBMs by three FEHBP plans
representing about 55 percent of FEHBP enrollment, we found that
the PBMs used three key approaches to achieve savings for FEHBP
participating health plans:

o passing on certain rebates negotiated with manufacturers to the
plans;

o obtaining drug price discounts from retail pharmacies and
dispensing drugs at lower costs through mail-order pharmacies; and

o using intervention techniques that reduce utilization of certain
drugs or substitute other, less costly drugs.

The FEHBP plans we reviewed also had formularies that include most
therapeutic categories, and these formularies had few restrictions
on which drugs enrollees could obtain. Each plan also provided
enrollees access to nonformulary drugs, although sometimes with
higher cost-sharing requirements than for the preferred formulary
drugs.

The PBMs were compensated through various methods, including
retaining some portion of the negotiated savings rather than
passing the full portion to the FEHBP plans. These compensation
methods also included collecting fees from FEHBP plans for
administrative and clinical services; retaining a portion of the
payments from the FEHBP plans for mail-order drugs in excess of
the prices negotiated with manufacturers to acquire the drugs; and
in some cases retaining a share of the rebates the PBMs negotiated
with drug manufacturers.

Mr. Chairman, this concludes my prepared remarks. I would be happy
to answer any questions that you or other Members of the Committee
may have.

Contacts and Acknowledgments

For future contacts regarding this testimony, please contact John
E. Dicken at (202) 512-7119 or at [email protected] . Contact
points for our Offices of Congressional Relations and Public
Affairs may be found on the last page of this testimony. Martha
Kelly, Assistant Director; Rashmi Agarwal; and Timothy Walker made
key contributions to this statement.

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Transmission, and Partner Notification. [17]GAO-06-681T .
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^3For example, H.R. 4, the Medicare Prescription Drug Price Negotiation
Act of 2007, was introduced on January 5, 2007. It would require the
Secretary of Health and Human Services to negotiate Part D drug prices on
behalf of Medicare beneficiaries.

^4For this testimony, we reviewed information summarizing approaches used
by members of the Organisation for Economic Co-operation and Development
(OECD). The OECD includes 30 member countries that "share a commitment to
democratic government and the market economy," and OECD's work includes
developing publications and statistics on economic and social issues.
http://www.oecd.org (accessed January 9, 2007). As appropriate, we present
examples of drug pricing approaches used in five OECD member countries
other than the United States.

^5A list of related GAO products is included at the end of this statement.
For additional information on approaches used by other countries, U.S.
private payers, and federal programs, see, for example, Congressional
Budget Office, Prices for Brand-Name Drugs Under Selected Federal Programs
(Washington, D.C., 2005); Congressional Research Service, Federal Drug
Price Negotiation: Implications for Medicare Part D (Washington, D.C.,
2007); Federal Trade Commission, Pharmacy Benefit Managers: Ownership of
Mail-Order Pharmacies (Washington, D.C., 2005); and Department of
Commerce, International Trade Administration, Pharmaceutical Price
Controls in OECD Countries: Implications for U.S. Consumers, Pricing,
Research and Development, and Innovation (Washington, D.C., 2004).

^6Growth in drug spending for these nations includes both prescription and
over-the-counter drugs.

^7Centers for Medicare & Medicaid Services, Trustees, National Health
Expenditure, Historical Data (Baltimore, MD: Centers for Medicare &
Medicaid Services, 2007),
http://www.cms.hhs.gov/NationalHealthExpendData/02_NationalHealthAccountsHistorical.asp
(accessed January 9, 2007). These figures reflect spending on prescription
drugs through retail outlet sales, but do not account for nonretail outlet
sales, such as those for drugs dispensed in inpatient hospital or nursing
home facility settings.

^8Therapeutically equivalent drug products can be substituted with the
full expectation that they will produce the same clinical effect as the
prescribed drugs.

^9PricewaterhouseCoopers. The Value of Pharmacy Benefit Management and the
National Cost Impact of Proposed PBM Legislation. A report prepared at the
request of Pharmaceutical Care Management Association. July 2004.

^10Brand drugs are single-source and multisource drugs that are marketed
under a proprietary, trademark-protected name. Single-source drugs include
those brand drugs that have no generic equivalent on the market and are
generally available from only one manufacturer. Brand multisource drugs
include those brand drugs that have generic equivalents available from
multiple manufacturers and are marketed under a proprietary name. Generic
drugs include multisource drugs that are chemically identical to their
branded counterparts and are generally marketed by multiple manufacturers
under a nonproprietary name.

^11In a 2000 report, the Institute of Medicine characterized the VA
formulary as "not overly restrictive."

^12DOD provides health care through TRICARE--a regionally structured
program that uses contractors to maintain provider networks to complement
health care provided at military treatment facilities.

^13Disproportionate share hospitals are hospitals that serve a relatively
large volume of low-income patients and are eligible for payment
adjustments under Medicare's prospective payment system or under Medicaid.

^14The 340B drug pricing program is named for the statutory provision that
authorizes it, section 340B of the Public Health Service Act (codified at
42 U.S.C. S 256b).

^15Drug manufacturers must participate in the 340B drug program in order
to get their drugs covered by Medicaid.

^16The Medicare Part B program covers a broad range of medical services,
including physician, laboratory, and hospital outpatient department
services and durable medical equipment.

^17In some cases, a plan may charge more or may not provide coverage for
drugs not listed on the plan's formulary.

^18See 38 U.S.C. S 8126(a)(4).

^19See 38 U.S.C. S 8126(a)(2). The nonfederal average manufacturer price
is the weighted average price of a single form and dosage unit paid by
wholesalers to a manufacturer, taking into account cash discounts or
similar price reductions. Big Four prices, in general, do not apply to
generic drugs.

^20As of June 2004, VA used one prime vendor, while DOD used five prime
vendors that serviced different geographic areas.

^21See 42 U.S.C. S 1396r-8.

^22Best price is the lowest price available from the manufacturer to any
wholesaler, retailer, provider, health maintenance organization, or
nonprofit or government entity, with some exceptions. Among other things,
sales made through the FSS, single-award contract prices of any federal
agency, federal depot prices, and prices charged to DOD, VA, Indian Health
Service, and Public Health Service are not considered in determining best
price.

^23AMP is defined by statute as the average price paid to a manufacturer
for a drug by wholesalers for drugs distributed to the retail pharmacy
class of trade. Under the rebate agreement manufacturers negotiate with
HHS, AMP does not include prices to government purchasers based on the
FSS, prices from direct sales to hospitals or health maintenance
organizations, or prices to wholesalers when they relabel drugs they
purchase under their own label.

^24State Medicaid programs receive an additional rebate for brand drugs
when a drug's AMP rises faster than inflation, as measured by changes in
the consumer price index.

^25See 42 U.S.C. S 1395w-3a.

^26The MMA also required HHS to implement a competitive acquisition
program (CAP) for certain Medicare Part B drugs. The CAP is a voluntary
program, which began in July 2006, that offers physicians the option to
acquire many drugs they use in their practice from an approved CAP
contractor.

^27Federal Employees' Health Benefits: Effects of Using Pharmacy Benefit
Managers on Health Plans, Enrollees, and Pharmacies. [33]GAO-03-196 .
Washington, D.C.: January 10, 2003.

(290601)

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Highlights of [35]GAO-07-358T , a testimony before the Committee on
Finance, U.S. Senate

January 11, 2007

PRESCRIPTION DRUGS

An Overview of Approaches to Negotiate Drug Prices Used by Other Countries
and U.S. Private Payers and Federal Programs

GAO was asked to describe how prescription drug prices are negotiated.
This testimony provides an overview of such efforts (1) by governments in
other countries; (2) by U.S. private payers, such as employer-based health
plans; and (3) by federal programs other than Medicare Part D. This
testimony is based on previous GAO reports from 2002 through 2006 on
federal programs that purchase or cover prescription drugs and other
relevant literature from congressional agencies and federal or
international organizations.

Governments in other countries use a range of approaches to limit the
amount they pay to acquire drugs:

o Ceiling prices establish a maximum price manufacturers may
charge for their products. Purchasers may sometimes negotiate more
favorable prices directly with drug manufacturers.
o Reference prices use local or international price comparisons of
drugs classified in a group as therapeutically similar to
determine a single or maximum price for all drugs in that group.
o Profit limits control how much profit a drug manufacturer may
earn per product or within a specified period of time.

Other factors--such as scope of coverage and national formularies, which
are generally lists of preferred drugs--influence drug price negotiations.

In the U.S. private health insurance market, health plans typically
contract with pharmacy benefit managers (PBM) to help manage their
prescription drug benefits. PBMs negotiate rebates or payments with drug
manufacturers, encourage substitution of generic drugs for therapeutically
similar brand drugs, and negotiate discounted prices with networks of
retail and mail-order pharmacies, passing along at least some of the
savings to health plans and enrollees. PBMs influence price negotiations
with manufacturers through formulary development and management and
through the large market share they often represent.

Approaches for negotiating drug prices vary among federal programs in the
United States. In part, these approaches depend on whether the programs
purchase and distribute drugs directly or reimburse retail pharmacies or
other providers for dispensing or delivering drugs. While the approaches
used by federal programs in the United States reflect U.S. laws, markets,
and health care delivery and financing, there are also elements common to
some of the approaches used by other countries and by private payers. Some
federal programs set ceiling prices, others establish prices by
referencing prices negotiated by private payers in the commercial market,
and still others rely on negotiations with manufacturers, directly or
through private health plans. For example, the Departments of Veterans
Affairs's and Defense's prices for a prescription drug may be the lowest
of a ceiling price, other established price, or a price negotiated with
the manufacturer. State Medicaid programs, joint federal-state programs
that finance medical services for certain low-income adults and children,
reimburse retail pharmacies for drugs dispensed to beneficiaries at set
prices. The programs receive rebates from manufacturers that are meant to
take advantage of the prices for drugs in the commercial market and are
required to reflect discounts and rebates negotiated by private payers
with manufacturers. For health benefits offered to federal employees,
retirees, and dependents, rather than negotiating with manufacturers, the
government contracts with participating health plans that typically use
PBMs to negotiate drug prices and offer other pharmacy benefit,
administrative, and clinical services.

References

Visible links
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16. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/cgi-bin/getrpt?GAO-06-971T
17. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/cgi-bin/getrpt?GAO-06-681T
18. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/cgi-bin/getrpt?GAO-06-646
19. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/cgi-bin/getrpt?GAO-06-69R
20. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/cgi-bin/getrpt?GAO-05-850T
21. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/cgi-bin/getrpt?GAO-05-555
22. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/cgi-bin/getrpt?GAO-05-102
23. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/cgi-bin/getrpt?GAO-04-718
24. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/cgi-bin/getrpt?GAO-03-650T
25. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/cgi-bin/getrpt?GAO-03-196
26. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/cgi-bin/getrpt?GAO-03-161
27. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/
28. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/
29. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/fraudnet/fraudnet.htm
30. file:///home/webmaster/infomgt/d07358t.htm#mailto:[email protected]
31. file:///home/webmaster/infomgt/d07358t.htm#mailto:[email protected]
32. file:///home/webmaster/infomgt/d07358t.htm#mailto:[email protected]
33. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/cgi-bin/getrpt?GAO-03-196
34. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/cgi-bin/getrpt?GAO-07-358T
35. file:///home/webmaster/infomgt/d07358t.htm#http://www.gao.gov/cgi-bin/getrpt?GAO-07-358T
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